THIS IS NOT FINANCIAL ADVICE
ABOUT PEER TO PEER AND MARKETPLACE LENDING
Peer to peer or marketplace lending has been around for some time. Advances in technology have made peer mediation platforms viable businesses in many sectors, including finance. Many of these mediation platforms like Uber and AirBnB have had disruptive effects on a massive scale in the markets in which they operate.
The retail capital market hasn’t been disrupted yet, but there are a number of companies who are exploiting pockets of the market that are under serviced or who see an opportunity to mobilise the capital of small investors for profit outside some of the constraints imposed on formal banking institutions by authorities like APRA.
There are two things to note from this. The first is that causing market disruption is not a license to print money. Disruption is a powerful economic force, but investors would do well to be wary. Uber is about as disruptive as they come and its services are in growing demand: but it’s not profitable (yet). The moral of that story is: ignore gloss and hype surrounding the concept of “disruptive companies”. Look at the fundamentals of any product you invest in.
The second is that there are two sources of yield these companies may be exploiting. One is improved credit and market efficiencies using data driven methods like machine learning, predictive analytics and information technology advances. It’s safe to say the more traditional incumbents in the lending market place are also investing in these on a grand scale.
Be wary of any claim that suggests that the secret to success is “data”. Yes, it is a secret to future success. But it’s an open secret – every nerd and her dog is working on it. That doesn’t make something special.
The other source of yield that many of these lenders are exploiting are those parts of the demand for capital not utilised by the banks due to restrictions that include the Basel accords. The Basel accords are intended to promote stability in the banking system and there are certain investments which the banks are no longer pursuing due to these restrictions.
This doesn’t mean that what these Fintechs are doing is unviable. It does suggest that some are targeting markets known to be more volatile and exposed to risk than the general retail credit market. That’s the main reason why the traditional banks are not competing in that space. Keep that in the back of your mind.
The economy as a whole is in a low yield pattern. If an offer is made to you that is significantly above other yields, one reason may be because the risk premium is high. Let’s not imagine that we can buck international macroeconomics simply by finding a clever product. Many of these products are clever: but they still sit in the same economic reality as everything else.
There are some questions that I think all investors should consider when researching these types of schemes:
- What is the nature of the investment? Is money distributed by a trust, or does the investor have a direct stake in the company? What are your rights as an investor if the loan you have invested in fails? What are your rights and exposures if the platform winds up: in a planned manner or otherwise?
- What is the diversification of your investment? Is it in one loan or a parcel of loans? To one borrower or multiple borrowers? That may be two different things- make sure you know.
- Are you able to decide the risk profile you are exposed to, or is it decided for you? Are you able to decide which specific loans you are exposed to, or is that decided for you?
- What is the credit management strategy for the company you are investing in? What is the rate of default or delayed repayments? What are the processes the company will go through in the event of a bad loan? Will recovery and legal fees be subtracted from your investment before repayment in this case?
- What is the status of the scheme? Registered with ASIC? Is there a credit license in play? A product disclosure statement? If not, why not? Are you comfortable with that answer?
- How are the loans provided secured? Are they under secured or do they have no security? Does your investment have a first or second charge on the assets concerned? Is a secured asset likely to appreciate or depreciate in value?
- Who are the people running the platform? Do they have credit experience? Do they have entrepreneurial experience? What other ventures have they established or worked on?
- How much do you have to put in? You may feel quite differently about a risk profile on a $1000 investment than a $25 000 investment. That’s reasonable.
- How much do you have to put in to diversify adequately within the platform? If a minimum investment is $1000, that’s not so much. But if you need to do that many times to diversify across different loans, that’s actually quite a large investment in one platform. Make sure you understand the minimum investment as well as the minimum investment to be diversified to your own satisfaction within that platform.
- What does diversification look like for you? Within a platform, how many different loans do you feel you need to be involved with to adequately diversify? Outside the platform, how does the investment fit within your overall strategy? Are you already heavily invested in property? If so, does mortgage-based peer to peer lending work in your interest? Are you already heavily invested in another sector? How does that affect your decisions?
None of these investments are risk free and many carry a substantial burden of risk. If someone is offering you a yield 10% or more above the bank bill swap rate, there’s a reason for their generosity. It doesn’t follow that it’s a bad investment, but it does follow that you should ask all the questions you need to satisfy yourself before deciding.
Can this class of products be successful investments? I think so. Are they appropriate for relying on as a primary income generating asset? In my opinion, no. But they may form part of a diversified investment strategy as a way to increase overall yield.
WHO DID WE RESEARCH AND WHY?
To start with, we looked at a large number of peer to peer offerings and got it down to a few we thought were offering a good combination of organization, returns and unique offerings in this market. We picked four that showcase the diversity of options available. Each product has different features and risks.
These are only four out of a growing number of organizations in this market. We intend them as examples of what’s possible in what is already a very diverse sector and as a starting place to research for your own investment decisions.
The products listed are not given in any particular order. Each is offering different rates of return, terms of investment, risk profiles and economic exposures. There are many more products available, with more developing all the time. You can use our research to inform your own thoughts as you research other products.
This is a very fast-changing environment. This analysis was performed August and early September, 2016. Advertised returns were re-checked on the providers’ websites on 08/09/16. Remember that rates of return and conditions change quickly, so check each provider’s website for up to date details.